The dramatic fall in the euro value against the dollar may mostly interest economists and financial market observers.

Still, the sinking euro is inflicting severe pain on all Europeans who are already distressed with rising inflation and economic stagnation. The euro has lost 10 per cent of its value this year and 14 per cent in the last 12 months. But no one can take it for granted that the correction is over. The psychological barrier of the euro parity with the dollar is now broken as the euro has reached a level never seen in the last 20 years.

The European Central Bank has for too long intervened to fill the economic management vacuum left by policymakers in the eurozone who never seem to agree on the reforms needed to make the currency union a cre­dible and sustainable reality. The underlying cause for the euro’s failure to convince currency markets and investors is that the eurozone continues to tolerate an unsustainable economic model of monetary union with no fiscal union.

The ECB is immersed in a dilemma that has been made acute due to the long-tail economic risks brought about by COVID and the still unresolved Ukraine war. On the one hand, Christine Lagarde, the ECB president, knows that raising interest rates strongly to curb the suffocating inflation that hit 8.6 per cent in June is now a high priority.

On the other hand, she fears that a rise in interest rates will increase borrowing costs for countries in the south burdened with high debt levels. Rising interest rates are a real threat to a quick economic recovery. The risk of the eurozone economies entering a spiral of rising prices and wages at a time of slow or negative economic growth is a reality that cannot be quickly addressed.

Looking at the brighter side of this depressing issue, one could argue that European exporters are more competitive because they can sell their products cheaper than other rivals with currencies pegged to the dollar. European multinationals are likely to gain when repatriating their profits from their foreign subsidiaries even if sales remain static.

Countries like Italy, Spain and France that attract tourists from the US are also likely to gain from the weakness of the euro.

There is a limit on how effective central bank intervention will be to calm the currency markets that show signs that they may no longer trust the ECB commitments

However, leisure travelling within the Union will suffer due to escalating travel costs mainly brought about by an increase in the price of aviation fuel compounded with the increase in the value of the dollar, which is the trading currency of most commodities.

The bleaker outlook linked to the sinking euro relates to other underlying threats to economic stability in the EU. Germany is the European economic locomotive with an economic model that relies on exporting high-value goods to the rest of the world. Still, its dependence on gas imported from Russia has exposed the weaknesses of its economic model. Four-and-a- half months of the Ukraine war have been enough to end more than three decades of German trade surpluses.

The risk management function remains one of the most challenging duties of policymakers at all levels of the economy. Carmen Reinhart, senior vice president and chief economist of the World Bank Group, was undoubtedly right when she said: “Prior to crises, it’s often the things that you don’t see that ultimately get you. There is reason to expect that many vulnerabilities remain hidden”.

Countries highly dependent on energy imports, like Spain and Greece, suffer from the escalating cost of buying energy that is primarily paid in dollars. Governments will do all they can to mitigate the impact on households and businesses. Still, there is a limit to the amount of support they can give without creating fiscal problems that will have to be resolved by taxpayers in the coming years.

As long as the EU’s political leaders continue to ignore the deep-rooted structural weakness in the governance model of the Union, the only bastion to support the euro will continue to be the ECB. But there is a limit on how effective central bank intervention will be to calm the currency markets that show signs that they may no longer trust the ECB commitments.

The ECB may, at some stage, make some verbal intervention to stem the depreciation of the euro that is putting additional pressure on inflation. Meanwhile, investors may still prefer to pour their money into dollar-denominated assets as they see the Federal Reserve as a more determined supporter of the US currency.

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